Gruber4e ch07

Public Finance and Public Policy Jonathan
CopyrightGruber
© 2012Fourth
WorthEdition
Publishers
Copyright © 2012 Worth Publishers 1 of 28
Public Goods 7
7.1 Optimal Provision of Public Goods
7.2 Private Provision of Public Goods
7.3 Public Provision of Public Goods
7.4 Conclusion
PREPARED BY
Dan Sacks
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 2 of 28
CHAPTER 7 ■ PUBLIC GOODS
7.1
Public Goods: A taxonomy
• public goods: Goods that are non-rival in consumption

and are non-excludable.
• Non-rival in consumption: One individual’s
consumption of a good does not affect another’s
opportunity to consume the good.
• Non-excludable: Individuals cannot deny each other
the opportunity to consume a good.
7.1
Defining Pure and Impure Public Goods
Is the good rival in consumption?

Yes No
Yes Private good Impure public good
Is the good (ice cream) (Cable TV)
excludable?
No Impure public good Public good
(crowded sidewalk) (defense)
7.1
Optimal Provision of Public Goods
How much of the public good should society provide?

• Markets will not provide the correct amount.
• To answer this question, start by reconsidering the
market for a private good, ice cream cones.
• Ben and Jerry have different tastes for ice cream (ic),
relative to the other good (c). How does the market
aggregate their preferences?
7.1
Horizontal Summation in the Private Goods Market
Ben’s Marginal Jerry’s Marginal Market
Benefit Benefit
Price Price Price
of ice of ice of ice
cream cream cream
cone cone cone
S = SMC
$2 DB $2 DJ $2 E
DB&J = SMB
0 2 Quantity 0 1 Quantity 0 3 Quantity

of cones of cones of cones
• To find social demand curve, add quantity at each

price—sum horizontally.
7.1
Optimal Provision of Public Goods
• With public goods, such as missiles (m), Ben’s

consumption doesn’t reduce Jerry’s.
7.1
Vertical Summation in the Public Goods Market
Price of Ben’s marginal benefit
missiles
$2
1
DB
0 1 5 Quantity of missiles
Price of
missiles Jerry’s marginal benefit
$4
2
DJ
Price of
missiles
$6
Social marginal benefit and cost
S = SMC
DB&J = SMB
7.2
Private Provision of Public Goods: Private-Sector
Under-Provision
The market does not produce the efficient amount of

public goods, because of the free rider problem.
• Free rider problem: When an investment has a
personal cost but a common benefit, individuals will
underinvest.
• Since Ben’s consumption of missiles also benefits Jerry,
Jerry may not want to pay (or vice versa).
7.2
APPLICATION: The Free Rider Problem in Practice
The free rider problem is one of the most powerful

concepts in all of economics.
• Radio and television programming:
o WNYC has an estimated listening audience of
about 1 million people, but only 7.5% of their
listeners support the station.
o The United Kingdom uses a non-market solution:
The BBC charges an annual licensing fee to anyone
who owns and operates a TV!
7.2
APPLICATION: The Free Rider Problem in Practice
• File sharing:
o 85% of users of a file sharing program download
files only from others.
o The file-sharing software Kazaa gives download
priority to users according to their ratings, thus
discouraging free riders.
• Bicycle shares:
o Users were expected to return each bike riding.
o Within four days, not a single bicycle was left.
o Literal example of a “free ride.”
7.2
Can Private Providers Overcome the Free Rider
Problem?
• The free rider problem does not lead to a complete

absence of private provision of public goods.
• Plenty of private-sector TV programming
• The private sector can in some cases combat the free
rider problem to provide public goods by charging user
fees that are proportional to their valuation of the
public good.
7.3
How Can We Measure Preferences for the Public
Good?
Three challenges in measuring preferences for public

goods.
1. Preference revelation: People may not want to reveal
their true valuation because the government might
charge them more for the good if they say that they
value it highly.
2. Preference aggregation: How can the government
combine the preferences of millions of citizens?
7.2
APPLICATION: Business Improvement Districts
Clean, safe sidewalks are public goods.

• Cities attempt to provide them through street repair
and police work, financed with tax revenue.
• But New York City’s Times Square in the 1980s was a
failure:
“Dirty, dangerous, decrepit, and increasingly derelict”
• In 1992, a group of private firms formed a “Business
Improvement District” to improve the area
themselves.
7.2
How did this BID work?

• A (BID) is a legal entity that privately provides local
services and funds these services with fees charged to
local businesses.
• How do BIDs overcome free rider problem?
• NYC law allows BIDs to levy fees on non-paying
members, as long as 60% of members contribute.
• Resounding success:
• Crime has dropped significantly.
• The area is cleaner and more attractive.
• Business and tourism are booming.
7.2
Resounding success:
• Crime has dropped significantly.
• The area is cleaner and more attractive.
• Business and tourism are booming.
• Success of BIDs depends on the legal underpinnings:
Can members charge fees to encourage payment?
7.2
Altruism and social capital.
Private markets provide public goods when people are

altruistic.
• Altruistic: When individuals value the benefits and
costs to others in making their consumption choices.
• Many laboratory experiments provide evidence for
altruism and show that people contribute to public
goods.
• How altruistic people are is measured by social capital.
.
7.2
Warm Glow
People might simply feel good about contributing to

public goods or charity.
• Warm glow model: A model of the public goods
provision in which individuals care about both the
total amount of the public good and their particular
contributions as well.
• Different from altruism because people don’t care
about just the amount of the public good.
7.3
Public Provision of Public Goods
Despite private provision, there is a role for government

provision of public goods:
• Under private provision, not everyone contributes to
the good, even though everyone benefits.
• Government provision potentially solves the problem
of non-contributors.
• Nonetheless, there are several challenges to
government provision.
7.3
Private Responses to Public Provision: The Problem
of Crowd-Out
• Crowd-out: As the government provides more of a

public good, the private sector will provide less.
• Warm glow: If people care about contributions per se,
they may continue to contribute even when the
government contributes.

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Public Finance and Public Policy Jonathan

• public goods: Goods that are non-rival in consumption

Is the good rival in consumption?

How much of the public good should society provide?

0 2 Quantity 0 1 Quantity 0 3 Quantity

• To find social demand curve, add quantity at each

• With public goods, such as missiles (m), Ben’s

The market does not produce the efficient amount of

The free rider problem is one of the most powerful

• The free rider problem does not lead to a complete

Three challenges in measuring preferences for public

Clean, safe sidewalks are public goods.

How did this BID work?

Private markets provide public goods when people are

People might simply feel good about contributing to

Despite private provision, there is a role for government

• Crowd-out: As the government provides more of a

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